After a volatile start to 2025, Japanese equities have reached record highs as resilient corporate fundamentals continue to offset external headwinds. Despite global uncertainties - from trade tensions and slowing international growth to elevated geopolitical risks - Japan’s underlying trends remain constructive. A transition toward moderate inflation, sustained wage gains, and improving corporate governance all provide a durable foundation for performance. The Tokyo Stock Exchange’s (TSE) reform momentum, coupled with the continued unwinding of cross-shareholdings, is driving better capital efficiency and higher shareholder returns.
Miyuki Kashima, head of investments, Japan, Fidelity International comments: “Japan’s pivot from deflation to mild inflation represents a defining structural shift in its economic and equity market outlook. For decades, persistent deflation constrained nominal GDP growth, depressed household income expectations, and encouraged corporate conservatism. Today, a combination of monetary, fiscal, and wage policies is supporting a more reflationary environment. Core CPI, which averaged above 3% in early 2025, is expected to moderate to around 2% by year-end, creating a sustainable inflation backdrop that supports real income growth and consumption. Importantly, this inflation is increasingly driven by wage dynamics and policy coordination rather than by cost-push pressures alone.
“Monetary policy continues to play a supportive role. The Bank of Japan (BoJ) has initiated a cautious normalisation process, gradually raising policy rates while maintaining an accommodative overall stance. Policymakers are proceeding carefully to balance the goal of anchoring inflation expectations with the risk of stifling growth. This deliberate pace is helping sustain favourable financial conditions, supporting equities while embedding inflation at levels consistent with long-term targets.
“Corporate governance reform has become a defining structural theme for Japanese equities, reshaping how companies allocate capital and engage with shareholders. The TSE’s initiative, urging companies trading below book value to improve governance, has acted as a powerful catalyst. Management teams are increasingly addressing inefficient balance sheets, exiting low-return businesses, and adopting more transparent communication with investors. The pace of this transformation has accelerated markedly since 2023, creating self-reinforcing momentum.
“Shareholder returns have risen sharply as a result. Share buybacks grew by nearly 90% year-on-year in FY2024 and have remained strong into 2025, despite global macro volatility. Companies across a broad range of sectors - from industrials to financials - have adopted buybacks as a flexible means to enhance return on equity (ROE) and optimise capital structures. Dividend growth has also gained traction, with payout ratios now approaching international standards. This evolution reflects not just a cyclical upturn but a fundamental change in corporate philosophy, as Japanese firms move decisively away from cash hoarding toward disciplined capital deployment.
“The gradual reduction of “parent-child” listings further underscores this shift toward capital efficiency. Historically, large conglomerates maintained listed subsidiaries for financial flexibility and visibility. However, regulatory pressure, together with investor activism and stewardship-driven engagement, has accelerated the unwinding of such structures. This process enhances transparency, improves governance, and strengthens shareholder alignment, which are core ingredients for sustainable market performance.
“As these reforms deepen, Japan’s corporate sector is on track for a structural improvement in profitability. After stagnating around 6-8% for much of the 2000s and 2010s, average ROE is now projected to reach 10% by FY2026 and 11% by FY2028. This sustained uptrend should narrow Japan’s valuation discount relative to global peers and reinforce the case for a long-term re-rating.
“On the political front, Japan’s leadership transition has generated headlines, but investors should view the shift as part of the country’s stable democratic continuity rather than a source of structural risk. While the Liberal Democratic Party (LDP) now governs as a minority administration, the fundamental policy framework underpinning Japan’s economic strategy remains firmly intact. Regardless of leadership changes within the LDP or the composition of coalition partners, the broad commitment to pro-growth, pro-reform, and reflationary policies endures. As such, political turnover is unlikely to disrupt Japan’s ongoing economic normalisation or derail its reform trajectory.
“The outlook for Japanese equities therefore remains positive. While short-term volatility linked to US trade policy or global monetary tightening cannot be ruled out, the medium-term drivers of earnings growth, rising ROE, stronger governance, expanding shareholder returns, and growing overseas investor participation all paint a favourable picture. Supported by reflationary dynamics and deep structural reforms, Japan is positioned to sustain its market leadership and continue its trend of economic and earnings growth. In a global context of uncertainty, Japan’s equity market stands out for its improving fundamentals, policy consistency, and enduring reform momentum, offering investors both resilience and upside potential in the years ahead.”
Looking for value in Japan
Min Zeng, portfolio manager, Fidelity International comments: “Recently, key indices in Japan have set new highs as both macro and micro fundamentals have proven to be more resilient than expected. While near-term vulnerabilities persist, underlying structural trends continue to provide a favourable backdrop for Japanese equities over the medium to long term. The transition to a mild inflation environment and the gradual normalisation of monetary policy in Japan are positive for both the domestic economy and the stock market. Japanese companies are raising prices and the latest spring wage negotiations are delivering higher levels of income growth.
“Against this backdrop, I see opportunities in sectors such as financials, construction, industrials and utilities, which all enjoy steady pricing power as labour shortages, digitalisation and infrastructure demand drive order books, while also having relatively limited sensitivity to US tariff outcomes.
“The banking sector is emerging as one of the clearest beneficiaries of Japan’s reflationary dynamics and governance reforms. Strong earnings momentum has been visible across the sector, underpinned by resilient net interest margins, lower credit costs, and progress in cost controls. The improving return on equity outlook for Japanese banks has been accompanied by heightened expectations for shareholder returns. In addition to dividend growth, management teams are signalling more ambitious share buybacks, supported by the unwinding of cross-shareholdings and more disciplined balance sheet management. The combination of rising profitability, improved governance, and higher capital efficiency suggests that Japanese banks could deliver sustained rerating potential, especially as the Bank of Japan gradually pursues policy normalisation.
The construction sector also presents a compelling outlook in this environment. Margins are expanding because contractors have regained pricing power. They are bidding selectively, focusing on large, high-productivity projects and pushing through price increases at the order stage. With labour capacity still tight and private capex rising, demand exceeds supply, so intake margins keep moving up. Reported results are catching the tailwind. Low-margin legacy jobs are rolling off, and revenue is increasingly recognised on newer, better-priced work. These trends are reinforced by the broader reform-driven backdrop: higher capital efficiency requirements and pressure to optimise asset portfolios are encouraging developers to recycle capital more actively, which in turn supports shareholder returns.
“Digital transformation remains a key structural theme, with Japanese corporates accelerating workflow automation due to an ageing labour force. I see opportunity in corporates that can capture revenues from domestic demand for system integration and cloud migration. Recent earnings reports have confirmed continued strong and defensive demand for software despite global economic uncertainty. Defence spending has emerged as a significant new theme, driven by Japan’s commitment to raise military spending to 2% of GDP. Increased political pressure due to potential tariff issues could sustain earnings growth in this area.
“In the near term, I expect market leadership to broaden beyond exporters as investors price in a more durable phase of domestic reflation under the new administration. Over the medium term, I continue to view Japanese equities as well placed to outperform global peers as reform, inflation normalisation and policy stability converge to strengthen earnings visibility and capital efficiency.”
